The Debt Limit and Stealth Taxes

“The weak economy and fresh tax cuts approved last month will help drive the federal budget deficit to nearly $1.5 trillion this year, the biggest budget gap in history and one of the largest as a share of the economy since World War II, congressional budget analysts said Wednesday.” See here.

This according to a Washington Post article. According to the media, it is not government spending causing the problem, it is the “fresh tax cuts.”


The tax cuts were not cuts, but rather extensions of existing tax rates. To argue that they are the cause of the deficits when spending has increased at historically high rates is ludicrous. But this is the left-wing or media viewpoint.

The big upcoming test of whether the current Congress is willing to bite the bullet and stop spending is raising the debt ceiling. At current rates of spending, the federal government will bump up against its debt limit as early as March. Treasury Secretary Timothy Geithner warns that it will be catastrophic if Congress doesn't increase Uncle Sam's credit limit. Is he correct? Since 1917, Congress has allowed the Treasury the discretion to issue new debt (i.e., borrow money from other agencies or individuals). Congress didn't want to completely give up its Constitutional requirement to control the purse strings, and so it set a cap on how much total debt the Treasury could owe at any given time. Currently the statutory debt ceiling is $14.294 trillion. As of January, the actual debt stood at slightly more than $14 trillion.

Geithner and other spokespeople for the executive branch argue that the world will end if Congress doesn't give them permission to run up more red ink. In particular, they claim that without the ability to borrow from new lenders, the Treasury won't be able to meet its existing obligations, including interest and principal payments on already-existing debt. The government will shut down. This is not true. If the debt ceiling is not increased, the Treasury can prioritize interest and debt payment to avoid a default and essentially put the government on a stringent pay-as-you-go basis.

Repudiating government debt eliminates future tax liabilities. To the extent that people correctly anticipate those future taxes, a reduction in them should increase the value of private assets (including human capital) over the long run by the same amount that the value of government securities falls. Thus, people will gain or lose depending how closely their wealth is associated with the State. If on the other hand, people underestimate their future tax liabilities, they suffer from a fiscal or "bond illusion" in which Treasury securities make them feel wealthier than they actually are. Debt repudiation will bring their expectations into closer alignment with reality, which should increase saving.

Raising the debt ceiling will not staunch default – just change the form of default. Default will occur either explicitly by reneging on payments, or implicitly by massive inflation — at some point anyway in the next decade or two. The increased debt will be monetized and the increased money supply will lead to inflation at some stage. This is the problem of fiat currency and with the Federal Reserve. They are stealth tax collectors. The danger of fiat currency is invisible to the public, professional investors, and political commentators. The collapse of the economy in 2008 permitted the Congress and Bush and then Obama Administrations to authorize an unprecedented quantity of government spending, which has been and will be funded in large part by trillions of freshly minted fiat currency. There can be no question that this is a seizure of wealth roughly equivalent to one year’s collection of income tax, yet there is more outcry over making a trivial increase in the topmost bracket from 35 percent to 39.6 percent.

So rather than allowing the stealth tax increases, I support not raising the debt limit and forcing Congress and the Administration to choose how to cut spending or raise taxes.